Investment bank Merrill Lynchsaid Friday credit and mortgage woes will lead to it post a third-quarter loss, as it takes almost $5 billion in writedowns in the wake of a credit crunch that paralyzed Wall Street this summer.
The bulk of the losses will come from marking down the value of complex instruments known as collateralized debt obligations and from declines in subprime mortgages -- loans given to customers with poor credit history.
Rising delinquencies and defaults on mortgages, especially subprime ones, has led to the near disappearance of investors willing to buy the loans. Without an investor market, the value of the loans decreased, leading to writedowns of portfolios. Subprime mortgages are often used in CDOs, pushing their value lower as well.
In total, Merrill said it would report a loss of up to 50 cents per share for the quarter. Analysts polled by Thomson Financial, on average, forecast earnings of $1.24 per share for the quarter ending Sept. 30.
About $4.5 billion of the writedowns are related to the declining value of subprime mortgages and CDOs. Merrill Lynch said it took significant steps to reduce its exposure to the subprime market in the third quarter.
Merrill Lynch is also writing down another $463 million, net of related fees, on the value of financing commitments for corporate buyouts, regardless of when the deals will close or fund. Many investment banks got stuck this summer with loans they pledged to private-equity firms for major acquisitions.
Merrill Lynch reduced these commitments to $31 billion at the end of the third quarter, down from $53 billion at the end of the second quarter.
Despite the third-quarter declines, Merrill Lynch's chairman and chief executive, Stan O'Neal, said in a statement that market conditions have shown recent improvement and are returning to more normal levels.
Merrill Lynch was not the only institution this week to announce its earnings would take a significant hit due to the declining mortgage market. On Friday, Washington Mutual Inc. said its third-quarter earnings would tumble 75 percent on loan writedowns and substantially higher provisions for loan losses.
At the beginning of the week, Citigroup said its quarterly earnings would fall 60 percent, as it planned to write down more than $3 billion in securities backed by underperforming mortgages and loans tied to corporate bonds.
Shares of Merrill Lynch rose 87 cents to $75.65 in morning trading. In general, shares of financial institutions have risen recently after warning of substantial losses, as investors take the warnings to mean the worst of the credit crisis is over.